We have debts to pay before we give ourselves tax cuts

By ROSS GITTINS

How much should we worry about leaving government debt to our children and grandchildren? A fair bit, though not as much as some people imagine.

The central claim of this year’s budget is that we can have our cake and eat it.

We can award ourselves personal income tax cuts worth $144 billion over 10 years, but still halt the growth in the federal government’s net debt at $350 billion by the end of June next year, and then have it fall away as the proceeds from successive, ever-growing annual budget surpluses are used to pay off the debt.

I’ve devoted much space to explaining how Treasurer Scott Morrison was able to conjure up this seeming fiscal miracle, by staging the tax cuts over seven years and by resorting to overly optimistic forecasts and projections.

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So how worried should we be by the possibility that the debt will keep growing despite ScoMo’s unbounded optimism?

Well, the first thing to remember is that the federal government isn’t like a household. A household or family has to be careful about how much it borrows because it has a finite life. Eventually, the kids leave home and mum and dad die.

Of course, many families borrow amounts that are several multiples of their annual salary to buy the home they live in. They’ll take 20 or 30 years to pay off their mortgage, but few people regard this as terribly worrying.

Treasurer Scott Morrison was able to conjure up this seeming fiscal miracle by staging the tax cuts over seven years and by resorting to overly optimistic forecasts and projections.Credit:Alex Ellinghausen

Why not? Because the home they buy provides them with a flow of service for as long as they need it to: somewhere to live. It saves them having to pay rent.

Buying your home is an investment in an asset and, provided the family can fit the mortgage payments within their budget, no one would accuse the family of “living beyond its means”. It would be living beyond its means, however, if it was regularly spending more on living expenses than its after-tax income.

By contrast, the government has an infinite life. It provides services for about 9 million households, who pay taxes that are usually sufficient to cover the cost of those services. As the people in those households die, their place is taken by others.

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If the households aren’t paying enough tax to cover the government’s spending, the government can always increase taxes. How many households do you know that can solve their money problems by imposing a tax on other households?

This is why it’s a mistake to imagine the rules that apply to your family also apply to the government. The government’s power to raise taxes means there’s never any shortage of people willing to lend it money.

Even so, there are some valid analogies between households and governments. A government can rightly be said to be living beyond its means if it’s not raising enough tax even to cover its day-to-day expenses.

This happens automatically when the economy turns down, and isn’t a bad thing: it helps to prop up the 9 million households when times are tough. But when the economy improves, the government needs to ensure its income exceeds its ordinary spending so the debt incurred isn’t left to burden people who gained no benefit from it.

And, just as a household shouldn’t be said to be living beyond its means because it’s borrowed to buy a home, so a government that’s borrowed to build worthwhile infrastructure – roads, rail lines, airports etcetera – shouldn’t be thought to be living beyond its means.

Why not? Because, like a house, that infrastructure will deliver a flow of services for decades to come.

If the children and grandchildren who inherit that debt also inherit the infrastructure it paid for, they don’t have a lot to complain about.

So, how much of the net debt can be attributed to living beyond our means while the economy’s been below par, and how much to investing in infrastructure that’s a valuable inheritance for the next generation?

This year’s budget statement four proudly informs us that the financial year just ending is expected to be the last in which the government will have to borrow to fully cover its “recurrent” spending to keep the government working for another year.

Yes, there is a fair bit of the total debt we should be getting on with paying off – and do so before we start awarding ourselves big tax cuts.

The government had to begin borrowing for recurrent expenses (including “depreciation” - the cost of another year’s wear and tear on the physical assets the government uses in its recurrent operations) from the time of the global financial crisis in late 2008.

Updating the figures provided in last year’s statement four allows us to calculate that the cumulative recurrent deficit over the 10 years is roughly $200 billion, although you’d have to add interest costs to that.

In principle, the rest of our net debt of about $340 billion by the end of this month has been incurred to build infrastructure, which will deliver a flow of services to the present and future generations extending over many decades.

So we need be in no hurry to pay off that part of the debt – it will do our offspring no harm.

But two qualifications. First, though economic theory indicates no level to which it’s prudent to borrow – it’s a judgment call – it is prudent to borrow less than the full cost – say, 80 or 90 per cent – of the infrastructure we build each year.

Second, it’s likely that a fair bit of the federal government’s spending on capital works has been selected more for political than economic and social reasons, and so won’t deliver much in the way of valuable services to the next generation.

If so, we should probably regard it as more in the nature of consumption or recurrent spending, and so pay for it ourselves rather than lumbering our kids with it.

All of which says, yes, there is a fair bit of the total debt we should be getting on with paying off – and do so before we start awarding ourselves big tax cuts.

Ross Gittins is economics editor of the SMH and an economic columnist for The Age. His books include Gittins' Guide to Economics, The Happy Economist and Gittins: A life among budgets, bulldust and bastardry.